Trial under way in Stockton bankruptcy case

Judge expected to reach a verdict by Thursday

Lawyers for the California city of Stockton said Monday it has cut its budget and services to the bone and has no choice about trying to become the most populous U.S. city to enter bankruptcy.

Creditors countered that the city has failed to cut enough spending or even seek a tax increase to avoid Chapter 9 bankruptcy protection.

The arguments came as the city faced off Monday with its creditors in U.S. Bankruptcy Court at a trial to decide the issue.

Stockton has become emblematic of government excess and the financial calamity that resulted when the nation's housing bubble burst.

Its salaries, benefits and borrowing were based on anticipated long-term developer fees and increasing property tax revenue. But those were lost in a flurry of foreclosures.

In his opening statement at the trial, Marc Levinson, an attorney representing the city, argued it has no other option but bankruptcy.

"Stockton is a city of 300,000, and I venture to say none of them is happy about bankruptcy," Levinson said.

Creditors, however, complained that Stockton had failed to negotiate cuts in the money it pays into the state pension fund, which represents its largest debt.

"The city is not insolvent," said Guy Neal, an attorney for the city's bond insurers. "The city has stacked the deck in favor of insolvency by padding the budget with non-essential expenditures. Stockton can and should do more to reduce expenses."

The creditors want the city to avoid bankruptcy, which would likely allow Stockton to avoid repaying the debts in full.

The trial will determine whether the city negotiated with its creditors in good faith before filing for Chapter 9 protection. The trial is expected to last four days.

During testimony, Neal grilled City Manager Bob Deis about the city budget, cost-cutting negotiations with labor unions, and whether Stockton had done anything to reduce the amount of money it owes CalPERS, the state pension fund, or even considered setting up its own plan.

Bankruptcy is opposed by the companies that issued and insured the bonds that Stockton used to pay millions of dollars in what had been unfunded pension obligations.

"The city ignores the 800-pound pension gorilla in the room," Neal said.

Deis explained the city needs its retirement plan to stay competitive in the job market and retain employees - especially law enforcement - at a time when the number of murders in the city has reached an all-time high.

"I ran the risk of a mass exodus of my employees, and at the time we were in crisis," Deis testified. "I couldn't run the risk of more police officer leaving my city when crime was out of control."

Neal even questioned the $130,000 the city pays annually to broadcast its council meetings on cable television, and whether it needs a deputy economic development director.

"Stockton is a unique community," Deis replied. "One in four lives in poverty. We have 17 percent unemployment today. I would say it's a much more important position to us than other communities."

The city was riding high in the early 2000s. The population had grown by nearly 20 percent between 2000 and 2005, and real estate tripled in value. A new arena went up near the city's waterfront.

Then the real estate bubble burst and home prices fell 70 percent, wiping out much of the tax base.

Within two years, Stockton had accumulated nearly $1 billion in debt on civic improvements; money owed to pay pension contributions; and the most generous health care benefits in the state. Coverage had been provided for life for all retirees plus a dependent, no matter how long they had worked for the city.

Last summer, the city began negotiating with creditors - a requirement before entering Chapter 9 bankruptcy. Ten employee unions have agreed to temporary wage and benefits cuts.

The biggest share of the debt is held by companies that in 2007 insured nearly $165 million in pension bond obligations to allow the city a lower interest rate and create stability for investors. The city proposed repaying 17 cents on the dollar.

If Chapter 9 protection is approved, a federal bankruptcy judge would still have to decide whether Stockton's bankruptcy plan is fair or singles out some groups to bear more of the financial burden than others.